With the prime brokerage (PB) industry having been shaken up by upcoming regulation and the Swiss National Bank (SNB) market shock in January 2015, it is in a transitional phase.
Many new shops have set up in recent months, with a wide range of business models and technology offerings.
|Patrick O’Brien, Exante|
“The growth in the market is coming from a new breed of prime-of-prime (PoP) entrants and, in some cases, providers looking to reinvent the traditional FX PB model.”
In some ways the influx of so many smaller, and therefore more nimble, players into the market is a challenge for the banks that traditionally dominated the space.
However, there is a general agreement that overall it has been a positive development for the industry, bringing new ideas and taking on some of the clients banks can no longer service as they look to reduce their balance sheets and increase their strategic focus.
While smaller funds were happy in the past to count a top-tier bank as their PB – and in many cases the termination of that relationship will have been disruptive – even those on the bank side admit those clients are probably getting more attention now if they have ended up with a smaller PoP.
The big banks still feel they have a compelling offering in the PB business. Those that have come through the SNB crisis argue that was just the latest in a long line of financial crises they have weathered, and that their clients can take comfort from the fact their platforms are tried and tested. What's more, there's no data that proves bank PB market share has materially dwindled in recent years amid new entrants.
It also seems clear that, while there is some competition between the two sides, they predominantly compete for different clients. The competition between the big banks for the big clients, and among the PoPs for the smaller clients, is more intense than that between the banks and the PoPs.
Many PoPs market themselves as a one-stop-shop solution for smaller funds without the resources themselves to secure the best pricing from the bigger prime brokers. It enables them to maintain relationships with multiple electronic communication networks via a single point of contact.
|Peter Plester, Saxo Bank|
So while the increasing cost of PB has made life more difficult for the smaller funds, and some strategies might no longer be viable on a smaller scale, for some the evolution of the business has simplified things, and even helped reduce costs overall.
Plester argues the industry is now adapting to the new market environment, not only in terms of regulatory changes but in the underlying structure of the market.
“FX has seen massive growth since prime brokerage was introduced to the market, bringing in new market participants and increasing activity,” he says. “The FX industry anticipated the regulatory scrutiny and adapted its business model, which is now much more similar to other regulated asset classes.”
Plester cites the example of Saxo’s pre-trade risk controls, which are the same changes as those imposed on the equities market a few years ago.
“Events like the flash crash showed how erratic algorithmic trading behaviour could be, and the impact it could have on the rest of the market,” he says.
However, the process remains ongoing. Many PoPs have sprung up in recent years, with different service and liquidity offerings.
Some will have found genuine niches in the market, offering specialization in specific strategies, for example, or innovative technology platforms that provide a real value-add for clients. Others will find themselves competing with other shops with superior offerings and are likely to fall away again, especially if and when another event such as SNB occurs.
Fund managers and other traders will ultimately determine which business models are most attractive, which will survive.
For many others there is likely to be failure or consolidation within the next 24 months, says one head of FX PB at a large bank. He likened the process to what was seen with central counterparty clearing houses a few years ago, when many small providers popped up before disappearing, having failed to gain traction.